Know your options and choose the right one for you
A pension is a crucial element of your financial plan and a great way to build wealth efficiently over the long term. Here’s how they work.
Pension basics
A pension is a way of saving money to live on when you decide to stop working. You typically pay in a portion of your earnings each year and can access that money after the age of 55 (or 57 from 2028).
The benefits of a pension are that, as well as the money you pay in, you’ll receive money from your employer and the government. That collective money is invested for many years, so it has the opportunity to grow significantly, and that growth is protected from tax.
When you reach retirement age, you’ll have various options to access your money, and it could provide an income for the rest of your life.
Types of pension
The main types of pension to be aware of are workplace pensions (which can be either defined benefit pensions or defined contribution pensions) and individual pensions (including stakeholder pensions, and self-invested personal pensions).
1. Workplace pension
Almost all UK residents over the age of 22 are auto-enrolled in a workplace pension through their employer (though you can opt out). These can work in two different ways.
Defined benefits pensions
DB pensions used to be very common, but these days, it’s unlikely you’ll join one. You may have an existing DB pension if you’ve worked for a large company or in the public sector.
With these pensions, once you retire, you’ll usually receive an income for life based on a portion of your final salary multiplied by the number of years you worked for that employer. The amount you receive isn’t affected by how much you have contributed, or by the performance of your investments.
Defined contribution pensions (DC)
DC pensions are now the most common type of workplace pension. With these, you’ll make contributions, usually as a percentage of your earnings, and you’ll receive tax relief from the government which will increase their value. Your employer will also make contributions.
The amount you receive in retirement is based on:
• How much you contribute. You can choose what percentage of your earnings you pay in.
• How much your employer contributes. They must pay a minimum of 3% of your earnings but many pay more.
• How much tax relief you receive from the government. This is added automatically to any of your personal contributions at a rate of 25%. You may be able to claim more in your annual self-assessment.
• How long your money is invested for. Starting early gives you the best chance of growing your wealth.
• The return your investments achieve. While this is difficult to predict, you may be able to choose an investment strategy that aims for higher returns.
• How much you pay in fees to your pension provider. Higher fees will leave you with less money in your account.
2. Individual pension
Any UK resident can choose to open an individual defined contribution pension, as well as, or instead of, a workplace pension. Options include a private personal pension and self-invested personal pension.
These work in largely the same way as workplace pensions, except that all decisions (e.g. which provider to choose, how frequently you contribute, etc.) lie with you and not your employer.
Maximising your pension
If you have any kind of DC pension (be it workplace or individual), there are actions you can take now to grow your wealth for your retirement.
These include:
1. Starting or increasing your contributions – Personal contributions are crucial to building wealth in your pension. The earlier you start or increase your contributions, the more potential this money has to grow.
2. Increasing your employer contributions – Check your contract to see how much your employer pays into your pension. Sometimes, if you increase your contributions, they will match them.
3. Choosing a pension that’s right for you – You can take control of your pension by choosing a provider that offers the investment strategy you want at a fee you’re willing to pay.
4. Keeping track of old pensions – If you move on from an employer, keep a record of the pension they paid into. You can transfer this money into a new pension if you want, though you should seek advice first to ensure you don’t lose any benefits.
5. Seeking advice – We can help you to understand and make the most of your pension, ensuring that you’re making the right decisions now to benefit you in the future.
If you’d like to get information specific to your personal circumstances, speak to us today.